Thursday, May 14, 2009

When to Initiate a Position ?

If you are like any other do-it-yourself individual investor, you would have been through this dilemma. When should I initiate a position? As per our individual investing style, criteria and risk profile, we have done our due diligence and come up with price that we are ready to pay. Now if we are in bull market, we do not hesitate and take a plunge. However, if we are in the bear market (like these days), then we hesitate to initiate our position. We start contemplating, should we wait a little bit more? This dilemma is more in case of dividend investors because YOC is sensitive to initial yield.

I have been through this dilemma quite often. Let is think this through with some rational reasoning.

  • It is just not possible to predict stock prices. If it were possible, everybody would rich and nobody would be losing money.
  • Any type of fundamental analysis that is done is based on past data, based on past economic environment, and based on how past managements have performed. A great company in past, can end up in mess with new management. Do we need to go through any examples?
  • Any type of technical analysis or chartists theories claims to predict short term movements in next few days or in some cases next few weeks. These are typically 5% to 10% differentials. If I am investing for long term with 10years, 15years, or even more, than these differentials are of no consequence.
I have made mistakes and learnt my lessons. The key is to learn, adapt, evolve, and move on. The well defined investment process based on principles of risk management helps me get over this dilemma. No amount of analysis (fundamental or technical) will save me from losses, if my process of evaluating an investing opportunity is wrong, or if my investing process has shortcomings, or if I do not have ability to stick with my risk criteria’s. If I am listening to market chatter, and continuing to wait for a stock to go down for higher initial yield, then I am deviating from my process. I am listening to folks who themselves have no clue what they are taking about or it may not be relevant to you.

What do I do?
Like any other do-it-yourself investor, I spend quite a bit of time to analyze a company and come up with fair value range. This fair value range is based on my personal risk profile (and not necessarily a fair value in absolute terms). I do not make any one time stock purchase for any given opportunity. In general, I spread it over a period of time. When the stock price falls in my fair price range, I initiate a small position equivalent to 30% of final expected allocation. I then continue to watch for six months or more. In this way, I can minimize my downward losses due to falling knife (note – I cannot avoid, only minimize). The next two installments are kept of future depending upon when there is next opportunity. If it is in fact a falling knife, then it will be obvious. If it is in fact an opportunity to invest, I add to my position, and hence help averaging down.

The message is, ignore the market chatter, identify a process for yourself, and stick to it. There is no investing process which is based on zero risk methodology. Accept the fact that we will incur short term losses.

In a well defined investing process, these short term differentials (loss or profit) will not have any noticeable impact in your longer term objectives.

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